Chapter Analysis of Financial Statements Flashcards by Kim s | Brainscape
KEY TERMS AND DEFINITIONS Asset Utilization Ratio: Asset utilization ratios the firm's ability to generate future revenues and meet its long-term obligations. Solvency refers to a company's ability to meet its long-term obligations. The income statement presents revenues earned by a company and corresponding. Generally, financial statements are designed to meet the needs of many diverse of an enterprise's present and continuing ability to generate positive cash flows The income statement presents a summary of the revenues, gains, of long- term debt, pensions, leases, income taxes, contingent liabilities.
These are explained below along with the advantages and disadvantages of each method. Horizontal Analysis Horizontal analysis is the comparison of financial information of a company with historical financial information of the same company over a number of reporting periods. It could also be based on the ratios derived from the financial information over the same time span. The main purpose is to see if the numbers are high or low in comparison to past records, which may be used to investigate any causes for concern.
For example, certain expenditures that are high currently, but were well under budget in previous years may cause the management to investigate the cause for the rise in costs; it may be due to switching suppliers or using better quality raw material. This method of analysis is simply grouping together all information, sorting them by time period: This analysis is also called dynamic analysis or trend analysis.
A disadvantage of horizontal analysis is that the aggregated information expressed in the financial statements may have changed over time and therefore will cause variances to creep up when account balances are compared across periods. Horizontal analysis can also be used to misrepresent results. It can be manipulated to show comparisons across periods which would make the results appear stellar for the company. For instance, if the profits for this month are only compared with those of last month, they may appear outstanding but that may not be the case if compared with the same month the previous year.15 3 Common Size Ratios
Using consistent comparison periods can address this problem. Vertical Analysis Vertical analysis is conducted on financial statements for a single time period only. Each item in the statement is shown as a base figure of another item in the statement, for a given time period, usually for year.
Typically, this analysis means that every item on an income and loss statement is expressed as a percentage of gross sales, while every item on a balance sheet is expressed as a percentage of total assets held by the firm. Vertical analysis is also called static analysis because it is carried out for a single time period. Advantages and Disadvantages of Vertical Analysis Vertical analysis only requires financial statements for a single reporting period.
It is useful for inter-firm or inter-departmental comparisons of performance as one can see relative proportions of account balances, no matter the size of the business or department. Because basic vertical analysis is constricted by using a single time period, it has the disadvantage of losing out on comparison across different time periods to gauge performance. This can be addressed by using it in conjunction with timeline analysis, which shows what changes have occurred in the financial accounts over time, such as a comparative analysis over a three-year period.
For instance, if the cost of sales comes out to be only 30 percent of sales each year in the past, but this year the percentage comes out to be 45 percent, it would be a cause for concern.
These accounting reports are analyzed in order to aid economic decision-making of a firm and also to predict profitability and cash flows.
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It is also called the statement of financial position. The two sides of the balance sheet must balance as follows: Current Assets Current assets held by the firm refer to cash and cash equivalents.
These cash equivalents are assets that can be easily converted into cash within one year. Liquidity is very important in terms of a company being able to operate on a day-to-day basis. For example, companies have to pay bills, salaries, purchase inventory for sale, meet loan commitments, etc. If … must investigate the company more before rendering a conclusion about the meaning of their PE ratio If a PE is really high, does that mean the company is overvalued and should be avoided?
The Classified Balance Sheet presents a snapshot of a company's financial position at a point in time. To improve users' understanding of a company's financial position, companies often group similar assets and similar liabilities together. This is useful bec… Common types of current assets are The order goes: On the bal… non-current assets item purchased by the business for use on a semi permanent basis Long-term investment are generally investments in stocks and bonds of other corporations that are normally held for many years.
This category also includes investments in long-term assets such as land or buildings that a company is… property, plant, and equipment assets with relatively long useful lives, currently being used in operations Accumulated depreciation The reduction to the cost of the asset.
It list the entity's assets, liabilities, and in the case of a corporation, the stockholders' equity on a specific date. The income statement presents a summary of the revenues, gains, expenses, losses, and net income or net loss of an entity for a specific period. This statement is similar to a moving picture of the entity's operations during this period of time.
The cash flow statement summarizes an entity's cash receipts and cash payments relating to its operating, investing, and financing activities during a particular period. A statement of changes in owners' equity or stockholders' equity reconciles the beginning of the period equity of an enterprise with its ending balance.
Items currently reported in financial statements are measured by different attributes for example, historical cost, current cost, current market value, net reliable value, and present value of future cash flows.
Historical cost is the traditional means of presenting assets and liabilities.
Notes to financial statements are informative disclosures appended to the end of financial statements. They provide important information concerning such matters as depreciation and inventory methods used, details of long-term debt, pensions, leases, income taxes, contingent liabilities, methods of consolidation, and other matters.
Notes are considered an integral part of the financial statements. Schedules and parenthetical disclosures are also used to present information not provided elsewhere in the financial statements.
Each financial statement has a heading, which gives the name of the entity, the name of the statement, and the date or time covered by the statement. The information provided in financial statements is primarily financial in nature and expressed in units of money.
The information relates to an individual business enterprise. The information often is the product of approximations and estimates, rather than exact measurements.
The financial statements typically reflect the financial effects of transactions and events that have already happened i.
Financial statements presenting financial data for two or more periods are called comparative statements.
Comparative financial statements usually give similar reports for the current period and for one or more preceding periods. They provide analysts with significant information about trends and relationships over two or more years. Comparative statements are considerably more significant than are single-year statements.
Comparative statements emphasize the fact that financial statements for a single accounting period are only one part of the continuous history of the company. Interim financial statements are reports for periods of less than a year.
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The purpose of interim financial statements is to improve the timeliness of accounting information. Some companies issue comprehensive financial statements while others issue summary statements.
Each interim period should be viewed primarily as an integral part of an annual period and should generally continue to use the generally accepted accounting principles GAAP that were used in the preparation of the company's latest annual report.
Financial statements are often audited by independent accountants for the purpose of increasing user confidence in their reliability. Every financial statement is prepared on the basis of several accounting assumptions: These assumptions provide the foundation for the structure of financial accounting theory and practice, and explain why financial information is presented in a given manner.
Financial statements also must be prepared in accordance with generally accepted accounting principles, and must include an explanation of the company's accounting procedures and policies. Standard accounting principles call for the recording of assets and liabilities at cost; the recognition of revenue when it is realized and when a transaction has taken place generally at the point of saleand the recognition of expenses according to the matching principle costs to revenues.
Standard accounting principles further require that uncertainties and risks related to a company be reflected in its accounting reports and that, generally, anything that would be of interest to an informed investor should be fully disclosed in the financial statements.
According to FASB, the elements of financial statements are the building blocks with which financial statements are constructed. Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. Comprehensive income is the change in equity net assets of an entity during a period from transactions and other events and circumstances from nonowner sources.
It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. Distributions to owners are decreases in net assets of a particular enterprise resulting from transferring assets, rendering services, or incurring liabilities to owners.
Distributions to owners decrease ownership interest or equity in an enterprise.
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Equity is the residual interest in the assets of an entity that remains after deducting its liabilities.